Developing confidence that an M&A deal makes economic sense can be a daunting task. This is certainly the case for investments from foreign bound sources, and especially true if aspects of the transaction involve U.S. regulatory clearances. Clearances can be required to address antitrust and export control issues, and are particularly prevalent when dealing with the energy and finance sectors. One regulatory clearance process, however, can trump all others and determine the ultimate destiny of any M&A deal: that is a national security clearance by the Committee on Foreign Investment in the United States (CFIUS).
What Is CFIUS
CFIUS, or the Committee, was created ostensibly out of concerns that foreign investment was coming into the United States unchecked and without consideration of security risks. There were fears, real and perceived, that this investment would weaken the ability of the United States to guard against the loss of critical technologies and military security. CFIUS was created in 1975 by executive order in reaction to investments from the Middle East. In the 1980s, as a result of Japanese investments, the President was given the power to block foreign investments following CFIUS investigation. And in 2007, in the aftermath of Dubai Ports World, a new CFIUS law was created that included additional reporting requirements and a broader national security focus, especially on foreign government controlled investments.
Because legislators and previous Administrations have wanted to ensure that the U.S. maintained an open investment policy, CFIUS is a voluntary process and focused narrowly on national security matters rather than broader economic considerations. CFIUS is a big Committee, composed of 16 departments and White House agencies all with diverse national security and economic mandates. While this large grouping helps ensures for balanced CFIUS decisions (between national security and open investment), it also can make for a cumbersome process. Reaching a unified decision requires immense internal efforts, and by design CFIUS must keep outside parties in the dark as to its deliberations. CFIUS determinations also can entail Cabinet-level decision making. Thus, Secretaries Gates, Clinton, Geithner and Locke, for example, and agency heads like Larry Summers and Dennis Blair (of the DNI) can themselves be involved in some of the most sensitive decisions on individual M&A transactions.
Understanding the Politics Outside of CFIUS
Most dealmakers are familiar with the Dubai Ports World transaction that was scuttled by political considerations in 2006. In that deal, Dubai Ports World (the fourth largest port operator in the world) sought to buy the global assets of a long-established British port operation company, P&O Ports. The deal was approved by CFIUS in a 30-day review. However, a disgruntled port operator in Miami, through lawyers and well-entrenched lobbyists, fought against CFIUS approval on Capitol Hill and in the press. The result was that their combined efforts exploded the transaction so thoroughly that not even a Presidential veto threat was powerful enough to stop its demise. This happened despite the fact that at the time more U.S. Navy ships docked in the UAE than any other port outside of the United States and that we were negotiating a free trade agreement with the country. All of this demonstrates that while CFIUS itself had focused its clearance decision on national security matters, the politics outside of the Committee can never be ignored.
Understanding What National Security Means to CFIUS
CFIUS is mandated by law to consider a number of factors in its national security analysis. Below are some of the central considerations that any M&A dealmaker should be aware of when determining whether their transaction should involve a CFIUS review.
Effects on defense production. Over 50 percent of all transactions that go through the CFIUS process in some way involve the U.S. Department of Defense. The majority of these transactions involve foreign buyers from countries with strong military ties to the United States. Thus, any target U.S. business with Defense Department contracts should be considered a prime candidate for CFIUS consideration.
Effects on critical technology leadership. CFIUS was created to guard against the loss of critical technologies. It is important, therefore, for the dealmaker to know what technologies are considered critical. CFIUS issues an annual report addressing whether there is a coordinated strategy to acquire U.S. critical technologies. The report provides a fairly detailed list of technologies considered ‘critical’, including: defense technologies, chemicals, advanced manufacturing, information technology, telecommunications, microelectronics, semiconductor fabrication, biotechnology, aerospace, energy, space systems and marine systems, among others.
Effects on long-term requirements for energy and other critical resources. The M&A dealmaker should be aware that CFIUS is mandated by law to consider energy matters as a national security factor. Other ‘critical resources’ can include items such as minerals, metals, and chemicals.
Effects on critical infrastructure. Understanding what constitutes critical infrastructure under CFIUS can be a moving target. CFIUS law clarified that CFIUS shall consider the particular assets involved in a transaction, rather than designating whole classes of assets as critical infrastructure. While this is helpful in understanding that not every US port will be considered critical, it also can present a challenge for a dealmaker when they are trying to gauge whether a power plant or other U.S. infrastructure would be considered critical infrastructure for CFIUS purposes.
Classified, sole-source, or sensitive U.S. government contracts. One of the key issues that CFIUS faces is the effect of foreign ownership on U.S. government contracts. This involves not only federal contracts, but also those on the state and local level. This is particularly true where U.S. businesses are the only suppliers of a particular good to the government. M&A transactions that include sensitive, sole-source or classified government contracts should be considered for CFIUS review.
Painful lessons in the CFIUS process
Playing hide and seek can really hurt when you get caught. The CFIUS process is voluntary, but only up to a point. Less than 10 percent of all foreign M&A goes through the CFIUS process (about 5 percent on average), and the vast majority of reviews are voluntarily initiated. However, some dealmakers choose not to file, even when they clearly should. The danger in not filing with CFIUS is the long-term potential consequences. Each CFIUS agency has its own process for identifying non-filed foreign M&A transactions and determining whether to request that parties file with CFIUS. A number of transactions have been fully consummated only to have parties later get a call from the Treasury Department (the Chair of CFIUS) requesting a filing. In a number of those cases, CFIUS placed conditions (mitigation obligations) on the transaction that were costly to the parties. Dealmakers should know that CFIUS has the ability to reach back and look at any non-filed transaction going back to 1988.
Sleeper contracts; knowing just what that company really does. Often dealmakers and their lawyers bring cases before CFIUS with the full expectation that the deal should go through quickly and painlessly. However, some find out that what the company does is much more important to CFIUS than what they first thought. This is because even small companies may have contracts, or sub-contracts, with government and/or non-government entities that have deep levels of classification. Meaningful and thorough due diligence is critical to identify the potential that such contracts exist, even if deal makers will not know the ultimate ends of those contracts.
Understanding your export control obligations. Another snag that often occurs in the CFIUS process involves export control compliance matters. Companies going though CFIUS often do not realize that Departments such as State and Commerce, as the agencies responsible for the U.S. export control laws, expect that companies going through the CFIUS process have taken care of their export control responsibilities before they file for review. For some companies, this may require a transfer of export licences or identifying products that could be subject to export controls.
Other countries problems can be your problems too. For the most part, the record of foreign companies stand on their own in a CFIUS analysis of a transaction. However, a company’s CFIUS review can be affected when, for example, the country in which they are headquartered has lax export control laws, or where it does not have strong policies to prevent the transfer of funds to terrorist. When evaluating an M&A transaction, a deal maker should consider the broader policies surrounding the foreign country where the buyer is domiciled.
M&A dealmakers must consider numerous issues when bringing a transaction to fruition. This should include understanding CFIUS and how it works. While sending a transaction through the CFIUS process does present costs, not doing so—or doing so without understanding the context of CFIUS and outside politics—can involve some unbearable costs.